Multifamily transaction activity slowed in the second half of 2022 and continues to remain muted due to pricing uncertainty. U.S. multifamily sales totaled $187 billion in 2022, down 16.1 percent from $222.9 billion in 2021, according to Yardi Matrix.
The Federal Reserve has raised its key short-term rate, the federal funds rate, nine times over the past year for a total of 475 basis points in an aggressive move to fight inflation. The Fed’s actions have led to a sharp rise in commercial mortgage rates, which have a significant impact on pricing, states Yardi Matrix. The 10-year Treasury yield, the benchmark for permanent, long-term financing, is now hovering around 3.5 percent, up from 2.3 percent one year ago.
“In the current climate with inflation and rising interest rates, we’re a bit more cautious, but no less active in scouring the market for great investments,” says Tim Donovan, director of investments for Midloch Investment Partners. “Investment sales are happening in this market, including by us, but it’s generally taking longer for buyers and sellers to agree on a price, and for buyers to raise the equity required to meet lender terms for permanent financing.”
In January, the Consumer Price Index rose 6.4 percent over the same period a year ago. While that’s significantly lower than the year-over-year increase of 9.1 percent in June 2022, it’s still much higher than the Fed’s inflation target of 2 percent.
Midloch, a real estate investment firm and fund manager with offices in Chicago, Milwaukee and Minneapolis, focuses on small- to middle-market joint venture equity investments, typically in properties valued between $5 million and $50 million.
The firm recently acquired three garden-style communities totaling 652 units in Wisconsin for $71 million. Midloch plans to make energy-efficiency improvements to the properties, which are located in Madison and Sheboygan.
Donovan states that more than 90 percent of Midloch’s existing debt is fixed versus floating, so there is less risk to rising interest rates.
“We typically borrow with five to 10 years of term, which generally provides enough runway to implement our business plans. In other words, we’re not usually short-term borrowers,” he says. “Fixing rates over the medium term mitigates negative impacts if rates go up.”
Midloch prefers to acquire properties with “features that tenants really appreciate,” according to Donovan. Examples include large floor plans, in-unit laundry and a comprehensive amenity package.
When it comes to location, Midloch seeks strong demographics such as high home values and household incomes. The firm invests across the country, but its core markets are in several Midwest markets including Columbus, Des Moines, Indianapolis, Kansas City Minneapolis and Madison, Wisconsin.
Donovan says that the amount of time Midloch holds an asset depends on the property itself. While there is no standard hold period, the firm typically sets a five- to seven-year expectation with investors.
“We’re opportunistic, and if the time is right, we’ll sell sooner. Similarly, we’ll hold longer if necessary to achieve our business plan objectives in terms of cash flow and appreciation,” he says.
Just as the hold period can differ, the renovation plan for each property is different based on the business plan. Typically, most capital improvements Midloch makes are to address deferred maintenance such as parking lots, roofs and landscaping, along with the clubhouse and amenity spaces. In-unit improvements vary depending on the specific property and are based on the end user.
“Sometimes we make upgrades in the interest of higher rents. In other cases, especially if the goal is to maintain affordability, improvements are more modest,” explains Donovan. “But refreshing properties and ensuring the safety of residents are always at the forefront.”
Midloch is also focused on energy-efficiency improvements. In its first week of ownership at one of the Sheboygan properties, Midloch made improvements to the underground parking lighting to reduce energy consumption to one-fiftieth of what it had been.
Renters stay put
Josh Purvis, managing partner for Terre Haute, Indiana-based Thompson Thrift Residential, says he is optimistic about the long-term supply and demand story for housing in the United States. One reason is that rising interest rates deter prospective homebuyers, making rental housing more appealing.
“We continue to remain bullish given the demand tailwinds and supply constraints in our target markets,” states Purvis.
According to Yardi Matrix, 269,000 apartment units were absorbed in the U.S. in 2022. The U.S. average occupancy rate fell 90 basis points to 95.3 percent during 2022 as more than 400,000 units were delivered.
This year, Thompson Thrift plans to break ground on 14 upscale multifamily communities. The firm recently acquired an additional 62 acres as part of the $550 million expansion of Fishers District in the Indianapolis suburb of Fishers.
Thompson Thrift began work on Fishers District in 2015. The expansion will provide a 7,500-seat event center, entertainment anchors, a mix of retail and restaurant space, luxury apartment homes and hospitality options.
Purvis says he is seeing strong interest from investment partners, residents and cities for suburban mixed-use developments like the one underway in Fishers. “These mixed-use developments create a sense of place and bring together the best of amenities, design and convenience.”
Thompson Thrift recently sold Watermark at Jordan Creek, a 176-unit apartment community in West Des Moines. Completed in 2015, the Class A property consists of four-story buildings with detached garages. Amenities include a resident social lounge, heated pool and spa, clubhouse, fitness center, dog park and community grilling areas. The community was 94 percent leased at the time of sale.
Local expertise leveraged
Kevin Villont, senior vice president of asset management for Oak Brook, Illinois-based JVM Realty Corp., says his firm’s investment strategy has not changed as a result of rising interest rates and inflation. However, he also points out that he has yet to see the true impact of what higher interest rates will have on deal flow and valuations.
Steve Meyer, JVM’s chief investment officer, acknowledges that long-term interest rates have increased in just the last few weeks. He says this action has reversed much of the inverted yield curve, driving permanent financing costs up. An inverted yield curve occurs when long-term interest rates are less than short-term interest rates. It is often an indicator of a recession.
“Permanent financing is still available, particularly from life insurance companies and somewhat from the agencies,” says Meyer. “But lending from banks is scarce.”
JVM acquires Class A multifamily communities with 150 or more units. They are typically garden-style or mid-rise assets with luxury common areas and amenities. Focused on the Midwest, JVM maintains a portfolio in suburban Chicago, Indianapolis, Kansas City and Wisconsin.
JVM recently acquired Courthouse Square in Wheaton, Illinois. The 149-unit apartment community was built in 2016 and consists of two six-story buildings. Amenities include a pool and sundeck, concierge services, package receiving, fitness center and yoga studio, event room, outdoor deck, heated indoor garage parking, pet wash and bike repair stations.
“The acquisition of Courthouse Square fits our long-term strategy of pursuing investments where we can leverage our local experience and extensive operating platform to enhance performance,” says Villont.
JVM will hold its properties anywhere from three to 10 years, according to Villont. Factors that affect the length of the hold include asset performance, general market conditions and anticipated need for capital improvements.
JVM evaluates the need for renovations separately at each community it owns. The firm also evaluates market conditions to determine if a renovation is necessary to compete in a particular market.
“There is no set time to renovate as we invest in capital improvements on a yearly basis to optimize our property management and revenue management strategies,” says Villont.
Above all, JVM seeks opportunities that provide cash flow and value appreciation for its investors.
— Kristin Harlow
This article originally appeared in the March 2023 issue of Heartland Real Estate Business magazine.